Osborne Should Think Again About Moody’s U.K. Rating Cut

By the Editors -
Feb 25, 2013

The decision by Moody’s Investors
Service to cut the U.K.’s credit rating is significant, though
not because it told financial markets anything they didn’t
already know about Britain’s limping economy. The move puts
George Osborne, the country’s beleaguered chancellor of the
exchequer, under even greater pressure to change course.

He ought to do just that. The reason isn’t the downgrade;
it’s that his policy is failing.

Osborne’s latest embarrassment is his own fault. He often
justifies his austerity-first fiscal policy by saying that,
without it, the country’s triple-A rating would be in jeopardy.
He attacked the previous government and even called for an
election when public debt was put on negative credit watch in
2009. Judged by his own criterion, he has flopped.

Osborne faces not just the routine derision of the
opposition Labour Party but, tellingly, mounting skepticism
within his own party. The course change the U.K. needs may
require a new chancellor, and the downgrade may have moved that
moment closer.

The chancellor isn’t relenting, however. Responding in
Parliament to a question about the downgrade, Osborne argued to
nobody’s surprise that the lowered rating didn’t matter. He said
there would be no change of course. “This government’s economic
policy is tested day in and day out in the markets, and it’s not
been found wanting today,” he said.

In a way, that’s true. The pound, drifting down for months,
fell to a new low against the dollar. Long-term interest rates,
on the other hand, hardly budged. On the first day of trading
after the downgrade, U.K. government bonds even performed better
than their top-rated German counterparts.

It would be strange had the markets reacted otherwise.
Aside from the timing, the downgrade wasn’t a shock: The ratings
companies mostly follow rather than lead the markets. Yet
Osborne’s critics inside and outside the ruling Tory Party will
draw strength from the setback, which adds to the uncertainty
about where economic policy is headed.

Here’s where it should head, as we’ve argued before. The
fiscal squeeze turned out to be too much, too soon. The
government’s zeal to stabilize the ratio of public debt to gross
domestic product is admirable, but its front-loaded approach
proved self-defeating. The Treasury subtracted too much demand
at a time when monetary policy, trapped by the floor on nominal
interest rates, can’t make up the difference. This has slowed
growth so severely that the debt ratio, far from falling, keeps
going up.

The U.K.’s continuing ability to borrow at very low
interest rates isn’t a signal that all is well with fiscal
policy, as Osborne says. Rather, it’s a sign of well-controlled
inflation expectations and untapped borrowing capacity. In other
words, it’s an opportunity to moderate the path of fiscal
consolidation by borrowing more in the short term. Doing so
would support the recovery and make the long-term goal of
stabilizing, then reducing, total debt more credible.

This is an awkward adjustment for a chancellor who rashly
emphasized the need for a big fiscal down payment and who likes
to boast about his refusal to deviate. Retreating under pressure
is something no politician -- least of all a tough-talking
British Tory -- likes to do. Yet that is what’s required. If
Osborne can’t find a way to do it, Prime Minister David Cameron
should replace him with somebody who can.